BitShares SmartCoins. They might be smart, but are they really stable?

Thursday 20 August 2015

BitShares is releasing a series of ‘pegged’ coins that are supposed to be immune from crypto’s signature volatility. But can we trust them?

Along with security, it’s one of the biggest problems in crypto. It might be nice to have control over your own money, but who would want that at the price of knowing the value of their account might fluctuate wildly over the course of a week, let alone months or years? In a short series, we'll be looking at some of the solutions out there.

Read also: Pegged - keeping bitcoin stable

There are various approaches to the problem of volatility in crypto. There a few centralised fiat-pegged assets - basically IOUs, which means you have to trust the issuer not to disappear or go bankrupt. As BitShares put it themselves, ‘History has repeatedly proven that issuers eventually go bankrupt due to fraud, incompetence, or government intervention. ’

Reliable decentralised solutions are few. BitShares claim, ‘A SmartCoin is a cryptocurrency whose value is pegged to that of another asset, such as the US Dollar or gold. SmartCoins always have 100% or more of their value backed by the BitShares core currency, BTS, to which they can be converted at any time at an exchange rate set by a trustworthy price feed. In all but the most extreme market conditions, SmartCoins are guaranteed to be worth at least their face value (and perhaps more, in some circumstances).’

BitShares uses the idea of a contract for difference to create a pegged asset. These are 200% collateralised (that is, each $1 of currency has $2 worth of currency to protect against moving prices). One party in the deal gets price stability, the other gets a leveraged bet on the outcome.


Hopefully BitShares will pan out just fine, but it will be a long way down if it fails. 

Fair enough. There’s the small matter of having to collateralise each BitUSD, or BitWhatever, with double the price of the actual asset, but it’s a neat idea for the end user. It’s gaining some traction, too: Danish exchange CCEDK will be using it for their NanoCard, which will allow realtime crypto-to-fiat payments on a debit card, from funds stored in a crypto address. 

Quite how these will perform in reality - and particularly under stress - is unclear. Preston Byrne has been extremely sceptical about the idea, which he criticises in his BitMarmot saga (worth a read). The acknowledged risk with SmartCoins is what happens if BitShares itself crashes in value, thereby destroying the collateral required to keep the peg in place. That’s relatively unlikely on a day-to-day basis, but if there’s anything that crypto has shown us, it’s that volatility is normal. A loss of market confidence, a bursting bubble, an unintended fork - all of these things can destroy the value of a crypto in minutes.

So it makes me a little uneasy that the apparent solution to crypto’s extreme volatility is vulnerable to, well, extreme volatility.

BitShares have come up with an interesting solution to one of crypto’s major drawbacks. It’s not perfect. It will likely work most of the time, and hopefully all of the time. But when it goes wrong, if it goes wrong - it will be spectacularly catastrophic. Investors will immediately lose confidence in the platform, creating a self-reinforcing cascade of selling and further ruining the peg. Let's hope it never happens.

Meanwhile, there are other solutions to volatility, which I’ll be looking at in the coming weeks.

Image: 'Wonderland Walker 2' by kevint3141

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